Friday, September 13, 2019

Doing more of what's failed for ten years will finally fail spectacularly..

It was a huge relief to see the charts of the Baltic Dry Index (BDI) and the U.S. retail sector ETF (RTH): both have soared to the moon, signaling that both the U.S. and global economies are booming: the BDI is widely regarded as a proxy for global shipping, which is a proxy for global trade and economic activity.

Amazon is 18% of the RTH basket of retail stocks, but the rest are conventional bricks and mortar chains with online sales: Walmart, Home Depot, Lowes, Costco, CVS, etc.

The American consumer must be ready, willing and able to spend freely since the retail sector is hitting new heights.

OK, now let's change channels from soaring market valuations to the real-world economy. What planet are buyers of BDI and RTH on? Maybe the shipping and retail sectors are incredibly robust on Sirius B, but here on Planet Earth the global economy is weakening, trade is stagnating, shipping is in recession, and retail sales and profits are stagnating.

Lumping all American households in one basket gives a false signal of financial health. If we look at averages, debt levels are reasonable, incomes are notching higher and so expectations of rising household debt and spending are reasonable.

But this radically distorts reality: only the top 10% are creditworthy and have rising incomes; the bottom 90% are over-indebted, poor credit risks and their income is stagnant and/or precarious.

The top 10% of households--a mere 12 million households--are also precarious, as much of their wealth and income is based on insanely overvalued asset bubbles in stocks, bonds and real estate. The wealth effect fuels their free-spending ways (recall that the top 10% collect roughly half of all income and account for almost half of all consumer spending).

As all the asset bubbles pop, the reverse wealth effect kicks in. Once households feel poorer, they tighten their borrowing and spending.

Another under-appreciated reality is the top 10% of households have much lower levels of debt (relative to their income) than the average middle-class household. This has several sources:

1. The top 10% hasn't needed to borrow as much for college, healthcare, vehicles, vacations, etc. because their higher income enables saving and paying cash.

2. The top 10%, especially the self-employed and small-business owners, tend to be debt-averse. They understand that debt is always a noose around the neck. As a result, the desire to take on more debt, even at near-zero rates of interest, is near-zero for many top 10% households.

3. The wealth effect is real for 10% households which have sold off bubble-valuation stocks, bonds, real estate, art, vintage autos, etc. The smart money has been selling these assets and pocketing the gains. The bottom 90% don't own enough bubble-valuation assets to move the needle on their overall wealth, income and financial security.

Globally, those who want to borrow more are poor credit risks while those who are creditworthy don't want more debt, regardless of how low interest rates fall. If we set aside the top 10% of households and enterprises, and focus on the creditworthiness and precariousness of the bottom 90%, we get a much more accurate picture of global debt exhaustion, a.k.a. debt saturation.

As I've written here recently, the recession that's unfolding isn't one triggered by crisis such as higher oil prices or a financial panic. It's a recession of debt exhaustion and diminishing returns as doing more of what's failed for ten years will finally fail spectacularly.

Wednesday, September 11, 2019

Financial bubbles manifest three dynamics: the one we're most familiar with is human greed, the desire to exploit a windfall and catch a work-free ride to riches.

The second dynamic gets much less attention: financial manias arise when there is no other more productive, profitable use for capital, and these periods occur when there is an abundance of credit available to inflate the bubbles.

Humans respond to the incentives the system presents: if dealing illegal drugs can net $20,000 a month compared to $2,000 a month from a regular job, then a certain percentage of the work force is going to pursue that asymmetry.

In our current economy, corporations have sunk $2.5 trillion in buying back their own stocks because this generates the highest work-free return. This reflects two realities:

1. Corporations can't find any other more productive, profitable use for their capital than buying back their own shares (enriching the managers via stock options and the 10% of American households who own 93% of the stocks)

2. Thanks to the Federal Reserve and other central banks injecting trillions of dollars of nearly-free credit into the financial sector, corporations can borrow billions of dollars to play with at near-zero rates that are historically unprecedented.

So borrow billions at 2.5%, pour it all into buying back your own stock and reap the gains as your stock rises 10%. Recall the basic mechanism of stock buy-backs: by reducing the number of shares outstanding, sales and profits go up on a per share basis--not because the company generated more revenues and profits, but because the number of shares has been reduced by the buy-backs.

(Note to New Green Deal advocates: if corporations reckoned they could earn more by investing the $2.5 trillion in alternative energy projects rather than stock buy-backs, they would have done so.)

As various sources have outlined, corporate stock buy-backs have been the primary driver of higher stock prices. This is driving the third dynamic of bubbles:

As the bubble continues inflating beyond any rational valuation, rational investors throw in the towel and join the frenzy. Once again, this willingness to abandon rationality is partly fueled by greed and also by a dearth of other more attractive investments.

A bubble economy is a sick economy, for bubbles are proof there is too much capital chasing too few productive uses for that capital. The Fed and other central banks have created trillions of dollars, yuan, euros and yen for corporations and financiers to play with, and to a lesser degree, for home buyers to play with via low mortgage rates and federal guarantees on mortgages.

As a result, the housing bubble is the one regular folks can play. And despite claims that it's not a bubble because of organic demand, housing is definitely in a bubble, along with stocks and bonds, art, etc.

When you create trillions of dollars, yuan, euros and yen out of thin air, you create the incentives to inflate bubbles. When your real economy is sick and offers few productive uses for all this excess capital, that only adds fuel to the speculative fire.

Here's the problem: all bubbles burst, regardless of other conditions. Creating more trillions won't change this, adding more gamblers to the casino won't change this, claiming a bubble economy is healthy won't change this and promising a trade deal with China won't change this.

All of America's bubbles will pop, and sooner rather than later. The stock market moves a bit faster than the housing and bond markets, but the bubbles that are visible in every market will all burst, much to everyone's dismay.

We can add a fourth dynamic of bubbles: nobody believes bubbles can burst until it's too late to get out unscathed.

Sunday, September 08, 2019

Either we root out every last source of rot by investigating, indicting and jailing every wrong-doer and everyone who conspired to protect the guilty in the Epstein case, or America will have sealed its final fall.

When you discover rot in an apparently sound structure, the first question is: how far has the rot penetrated? If the rot has reached the foundation and turned it to mush, the structure is one wind-storm from collapse.

How deep has the rot of corruption, fraud, abuse of power, betrayal of the public trust, blatant criminality and insiders protecting the guilty penetrated America's key public and private institutions? It's difficult to tell, as the law-enforcement and security agencies are themselves hopelessly compromised.

If you doubt this, then please explain how 1) the NSA, CIA and FBI didn't know what Jeffrey Epstein was up to, and with whom; 2) Epstein was free to pursue his sexual exploitation of minors for years prior to his wrist-slap conviction and for years afterward; 3) Epstein, the highest profile and most at-risk prisoner in the nation, was left alone and the security cameras recording his cell and surroundings were "broken."

If this all strikes you as evidence that America's security and law-enforcement institutions are functioning at a level that's above reproach, then 1) you're a well-paid shill who's protecting the guilty lest your own misdeeds come to light or 2) your consumption of mind-bending meds is off the charts.

How deep has the rot gone in America's ruling elite? One way to measure the depth of the rot is to ask how whistleblowers who've exposed the ugly realities of insider dealing, malfeasance, tax evasion, cover-ups, etc. have fared.

America's ruling class has crucified whistleblowers, especially those uncovering fraud in the defense (military-industrial-security) and financial (tax evasion) sectors and blatant violations of public trust, civil liberties and privacy.

Needless to say, a factual accounting of corruption, cronyism, incompetence, self-serving exploitation of the many by the few, etc. is not welcome in America. Look at the dearth of investigative resources America's corporate media is devoting to digging down to the deepest levels of rot in the Epstein case.

The closer wrong-doing and wrong-doers are to protected power-elites, the less attention the mass media devotes to them.

As for Corporate America's fraud and corruption: No Wrongdoing Here, Just 6,300 Corporate Fines and Settlements (May 2015). Prosecutors no longer indict bankers, CEOs or top executives. Wrist-slap fines are deemed adequate punishment, even when corporate managers have reaped billions of dollars in profits selling highly addictive and dangerous drugs while claiming they're safe and non-addictive.

The tens of thousands of Americans who've died from these drugs suggest this was never true.

All this rot--corruption, fraud, abuse of power, betrayal of the public trust, tax evasion, blatant criminality and insiders protecting the guilty--has consequences. As I explained in Crony Capitalism Is Kryptonite to Democracy and the Real Economy (October 6, 2014), When the machinery of governance is ruled by the highest bidders, democracy is dead. (Hmm, why is Facebook suddenly spending $100 million on lobbying?)

Or as correspondent Simons C. recently put it:"The ethical dimension underpinning the whole system is this: what's moral is what's legal and what's legal is for sale."

Here are America's media, law enforcement/security agencies and "leadership" class: they speak no evil, see no evil and hear no evil, in the misguided belief that their misdirection, self-service and protection of the guilty will make us buy the narrative that America's ruling elite and all the core institutions they manage aren't rotten to the foundations.

Either we root out every last source of rot by investigating, indicting and jailing every wrong-doer and everyone who conspired to protect the guilty in the Epstein case, or America will have sealed its final fall.

Thursday, September 05, 2019

If these three charts reflect a "normal" "healthy" Bull market, then why are they so uncommon?

The implicit narrative of the latest rally in stocks is that this is just another normal rally in the ongoing 10-year long Bull market. Nice, but do these three charts look "normal" to you? Let's take a quick glance at a daily chart of the S&P 500 (SPX), a weekly chart of TLT, the exchange-traded fund of the US Treasury 20-year bond, and silver.

In other words, let's look at three different assets: stocks, bonds and one of the precious metals.

Even the most cursory glance reveals there is nothing normal about any of these charts. The recent action in the SPX is anything but normal: yet another announcement of yet another (low-level nothing-burger) trade meeting opens a gap big enough for a semi to drive through, punching through the upper Bollinger Band, and on the heels of a previous big gap up, also on no fundamental news.

Look at August: if a month of nearly daily open gaps and manic swings is "normal," why are such periods so uncommon in "normal" rallies? Looking at August's wild schizophrenia, does this strike you as "normal" market action in an ongoing Bull market? If so, perhaps you should dial back your Ibogaine consumption.

Next up, TLT, the US Treasury long bond. You know, the "safe" long bond, which moves glacially compared to risk-on stocks.

If we dare to be honest (risky in a world terrified of honesty), this looks like the blow-off topping move of risk-on bitcoin in December 2017. There is nothing "normal" about this parabolic move in Treasury bonds.

Now let's consider silver, like its precious metal sibling gold, traditionally a hedge against currency devaluations and other risky spots of bother. Since when is a parabolic move higher in the precious metals a sign of a healthy stock market rally or healthy economy?

Um, how about "never"? Let's face it, these are not charts of a healthy stock market. They're signs of the manic uncertainty and frenzied churn of traders desperately seeking the next parabolic rally in risk-off hedges.

That the entire stock market rally rests on empty rumors and recycled central bank happy talk is beyond pathetic. There is nothing normal or healthy in these charts or in a pathological reliance on addled double-speak to push stocks higher.

Wednesday, September 04, 2019

Any domino-like expanding crisis will unfold in a status quo lacking any coherent response.

Longtime readers know I've often referenced The Fourth Turning, the book that makes the case for an 80-year cycle of existential crisis in U.S. history.

The first crisis was the constitutional process (1781) following the end of the Revolutionary War, whether the states could agree on a federal structure; the 2nd crisis was the Civil War (1861) and the 3rd crisis was global war-- World War II (1941).

According to this proposition, we're fast approaching an existential crisis that could upend the status quo in a fundamental fashion.

While there is a great deal of historical evidence for cycles, predicting a major transition based on previous cycles is obviously a guess rather than a certainty.

So will everything change in 2020-25, or will the present simply extend another five years? We have to start by defining what qualifies as fundamental change. In my view, if the current distribution of income, power and ownership of capital remains unchanged, nothing of import has changed.

There might be dramas playing out in the political theater, but if the asymmetrical distribution of income, power and wealth doesn't change, then the dramas are merely another form of distraction / entertainment.

The other type of change that qualifies as fundamental is the breakdown of the structures of everyday life: the distribution, cost and availability of food, fresh water, energy, healthcare, income and basic security.

One way to measure the vulnerability of any society to breakdown or a fundamental reshuffling of income, wealth and power is to examine its buffers--the resiliency and reserves of the core systems.

I often reference buffers, as these are largely invisible to everyone who isn't intimately familiar with the workings of each system: the reserves that can be drawn upon in crisis, the redundancies, the staff and management training to handle crises, and so on.

Two examples that are often referenced are the supplies of gasoline in service stations and the food in supermarket shelves and coolers. Each commodity--food and fuel--are largely "just in time," meaning that the supply and distribution system is a long, complex chain with minimal buffers, as the systems have been optimized for efficiency not resilience.

Any disruption in any link of the supply chain will break the entire chain.

The ultimate buffer for any nation-state is its currency, a.k.a. "money." If its currency still acts as a store of value globally, the nation in crisis can issue more money to buy whatever is needed to alleviate the crisis.

If trust in the value of the money has been lost by over-issuing new currency, this buffer has been depleted.

Social and cultural buffers are more difficult to assess. Deeply corrupt societies may find that the public's patience with the abuses of power that manifest as endemic corruption has thinned to the point that mustering the police and army no longer protects the status quo.

Natural systems also have buffers, and the industrial civilization we inhabit takes a variety of natural resources--fuels, fresh water and fertile soils--for granted, assuming that brute force (more chemical fertilizers, more wells, more fracking, etc.) will guarantee ample supplies of these essentials.

Financial systems have multiple points of resilience or fragility. If we take the 2008 Global Financial Meltdown as an example, the Federal Reserve created or backstopped / guaranteed an astonishing $27 trillion out of thin air to restore trust. (The first tranches totaled $16 trillion.)

It worked a decade ago, but saving the banks does not necessarily restore the "animal spirits" of borrowing more money to chase assets higher, and it certainly doesn't boost investments in productivity, the ultimate source of broad-based prosperity.

It also doesn't create more income for heavily indebted borrowers, and with interest rates globally at or near zero (or even lower), there is very little room to lower the cost of servicing existing debt.

It certainly feels as if financial "fixes"--making it cheaper to borrow and refinance existing debt--have run their course, and have entered the fatal decline of diminishing returns: every additional dollar of debt adds less and less real growth to the economy.

I've also referenced institutional sclerosis and the rising wedge model of breakdown, in which costs and complexity continue edging higher while the output of the higher costs and complexity stagnate.

One example of how finance, politics and institutional fragility come together is public pensions, many of which are based on unrealistic financial projections of endlessly rising profits, capital gains and taxes.

We are now in the longest expansion in modern history, yet it doesn't feel as robust as the expansions of the 1950s to early 1970s (les trente glorieuses, the "glorious 30" years of magical expansion 1945-1975) or the financialization/cheap oil boom of the 1980s or the Internet boom of the 1990s.

History informs us that crises that could have been handled with relative ease in the past, when buffers were wide and core systems were resilient, end up triggering a domino-like collapse of entire empires.

These phase shifts often follow periods of financial depression, drought or pandemic (the three often go together as people who get less to eat have compromised immune systems that are then vulnerable to epidemics) that erode the economy and core institutions.

If we put all this together, it seems we are facing a much different type of crisis this time, one in which the core systems of the economy and society have become increasingly fragile behind the thin facade of stability, and are thus more vulnerable to disruption.

The crisis of 1781 was essentially a struggle to balance the forces of state and federal power, a balance that already included the divisive issue of slavery.

By 1860, the political compromises that had duct-taped the Union without actually resolving the great divide between slave and free states collapsed, and the issue was resolved by war.

In 1941, a U.S. possessive of its relative isolation was forced to choose between an increasingly precarious isolation and a decisive battle with the Nazi Reich and the Japanese Empire.

What might change in 2020-2025? Perhaps nothing, if all the duct-taped "fixes" for the increasing asymmetries of income, wealth and power hold, and food, fresh water and energy remain cheap and abundant.

But it feels as if the resiliency of society, governance and the economy have thinned to the point that any one domino falling might knock down many others, leading not to a specific crisis such as war or a political struggle, but a generalized failure of the entire status quo: a collapse of indebtedness, a collapse of overly complex and unaffordable institutions, a sharp drop in the purchasing power of fiat currencies, a loss of faith in political processes, a collapse of trust in technocratic expertise and the mass media, and possibly scarcities of essentials that could drive prices much higher.

History suggests these systems are all interconnected and interdependent (i.e. tightly bound systems), so the collapse of one system triggers crises in all the systems it is connected to.

The possibility of such a cascading crisis of the entire status quo isn't even on the radars of the government, media, academia, corporations, etc. There are indications that the Pentagon has contingency plans that recognize the fragility of global systems, but at this point any domino-like expanding crisis will unfold in a status quo lacking any coherent response.

This essay was drawn from Musings Report 27. The Musings Reports are emailed weekly to subscribers and patrons at the $5/month or higher level.

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